Compensation & Benefits – Module 1

Module 2: (6 Hours)
Defining Internal Alignment: Definition of Internal Alignment, Internal Pay Structures,
Strategic Choices in Internal Alignment Design, Internal Structure.

Defining Internal Alignment:

There three are common bases for today’s pay structure.
1. The content of the work: It is a kind of work employee does.
2. The skills and knowledge required to perform the job.
3. Its relative value for achieving the organization’s objectives.
If systematic procedure is not acceptable to the parties involved, employee will start murmuring
and this results in to turnover and resistance for new technology. Systematic procedure of
compensation brings clarity among the people and reduces potential losses to company.
In this module we study following components in detail:
 Compensation Strategy: Internal Alignment
 Structures Vary Among Organizations
 What Shapes Internal Structures?
 Strategic Choices in Designing Internal Structures
 Consequences of Structures

COMPENSATION STRATEGY: INTERNAL ALIGNMENT

Setting objectives is the first issue in a strategic approach to pay, and second is internal
alignment. Alignment addresses relationships inside the organization. Also it tells how do the
responsibilities and pay of different designations are related. Internal alignment, often called
internal equity, refers to the pay relationships among different jobs/skills/competencies within a
single organization it addresses the logic underlying these relationships. Internal alignment of
salary depends on the responsibilities of different positions in the organization.

The relationships form a pay structure that should:

a. Support the organization strategy.
b. Support the work flow.
c. Motivate behavior toward organization objectives.
Pay structure refers to the array of pay rates for different work or skills within a single
organisation. The number of levels, the differentials in pay between the levels, and the criteria
used to determine those differences describe the structure.
a. Supports organization strategy: Lockheed decided six levels of engineering work would
support the company’s strategy of researching, designing and developing advanced
technology systems.
Exhibit 1: Engineering Structure at Lockheed Martin, the world’s largest defense
contractor. Lockheed also builds rockets, shuttles, and Martian rovers for NASA.

b. Supports work flow

Work flow is a process by which goods and services are delivered to the customer. The pay
structures out to support the efficient flow of that work and design of the organisation.

Example: Merrill Lynch, customer associates & financial advisors.

Merrill Lynch divided its clients in to five groups based on net worth: investor, emerging affluent
(wealthy), affluent, high net worth, and ultra high net worth (the “whales”) then it revamped its
job structure to match accordingly. To support the new financial advisor job structure, Merrill
Lynch designed a new pay structure with aggressive bonus and stock incentives that are a
substantial part of the new pay structure.
c. Motivates behavior: Internal pay structures are part of the network of returns for pay
increases through promotions, challenging work, and greater responsibility as one moves up
in organization structure. The challenge is to design structures that will engage people to help
achieve organization objectives. The organization structure out to make clear the relationship
between each job and the organization’s objective. This is an example of “Line-of-sight”.
Structure must be fair to employees.

STRUCTURES VARY AMONG ORGANIZATIONS

 An internal pay structure can be explained with the help of
i. Number of levels of work
ii. Pay differentials between the levels
iii. Criteria or basis used to determine those levels and differentials
i. Levels: One character of any pay structure is its hierarchical nature that is based on
number of levels and reporting relationships. Some structures are more hierarchical,
with multiple levels; others are compressed with few levels.

Exhibit 2: Managerial/Professional Levels At General Electric Plastics (GEP)

ii. Differentials: The pay differences among levels are referred to as differentials. If we
assume that an organization has a compensation budget of a set of amount to
distribute among its employee, it follows the compensation budget allocation and
divide it in different ways. Thus pay is determined by:
o Knowledge/ skills involved
o Working conditions
o Valued addition to the company
 One intention of these differentials is to motivate people to strive for promotion to a
higher-paying level
Exhibit 3: Exploring Pay Structure at Lockheed Martin

 Criteria: Content and Value: Work content and its value are the most common base for
determining internal structure. Work Content means the work performed in a job and
how it gets done (tasks, behaviors, knowledge required, etc.). Structure ranks jobs on –
skills required complexity of tasks, problem solving, and/or responsibility. The Value is
the worth of the work; its relative contribution to the organization objectives. Structure
based on the value of the work focuses on – relative contribution of these skills, tasks,
and responsibilities to the organization's goals. It can include external market value (that
 is what competitors pay for the job) or rates agreed upon through collective bargaining,
statutory rates.
Use Value and Exchange Value
 Use value – the value of goods or services an employee produces in a job.
 Exchange value – whatever wage the employer and employee agrees on for a job.
Examples IBM software engineers at Bangalore, Kiev and Purchase, New York.
o Difference between exchange value and use value surfaces when one firm
acquires another, IBM acquisition of PricewaterhouseCoopers (PWC). PWC
Consultant are lifeblood of the company helped IBM marketing teams, use value
of the PWC consultant with in IBM differed from their use value within PWC.
Similar marketing jobs in two different companies may be valued differently based on
how they contribute to organization objectives
Job- and Person-Based Structures: Job-based structures depend on the work content that
includes tasks, behaviors, A Person-based structure shifts the focus to the employee skills,
knowledge, or competencies the employee possesses whether or not they are used in the
particular job. In reality, both job-and-person-based structures are included.
WHAT SHAPES INTERNAL STRUCTURES?
The major factors that shape internal structure are categorized in to external and organization
factors even though they are connected and interact.
 Exhibit 4: What Shapes Internal Structures?
 External Factors
1. Economic pressures: Early advocates emphasized economic market forces influence pay
structures: Adam Smith faulted new technology associated with industrial revolution. Karl
Marx quoted employer unfairly pocketed the surplus value created by the difference between
use and exchange value and suggested that worker must over through capitalist and take the
full benefit.

Marginal productivity – says that employers do in fact pay use value. Unless an employee
can produce a value equal to the value received in wages, it will not be worthwhile to hire
that worker. One job is paid more or less than another because of differences in relative
productivity of the job and/or differences in how much a consumer values the output.
In addition to supply and demand for labor and products and services also affect internal
structure. Turbulent changes in products/services or in customers’ tastes force organisation
to redesign pay structure.

2. Government policies, laws, and regulations: In many countries legislation prohibits pay
systems that discriminates on the basis of gender, race, religion, or national origin. The
Equal Pay Act and Civil Rights Act emphasizes “equal pay for equal work” with considered
equal if equal skill, equal effort, equal responsibility is performed under equal working
conditions. Legislations also aim at the differentials they focus on Living wage that aims at
minimums or (Minimum-wage legislation) and maximums (executive pay).

3. External stakeholders: Unions, stockholders, and even political groups have a stake in how
internal pay structures are determined. Unions seek smaller pay differences among jobs and
seniority-based promotions as a way to promote solidarity among members. Stockholders
are also interested in the differences between what executives make compared to others in
the organization.
i. Have a stake in how internal pay structures are determined
ii. Internal alignment focuses on pay differentials within an organization.

4. Cultures and customs: Culture definition of culture is “the mental programming for
processing information that people shares in common” Shared mind-sets may judge what
size pay differential is fair.
In ancient Greece, Plato declared society will be stronger if rich earn four times higher than
the lowest. Aristotle favored a five-time limit. In 14th century Western Europe, the Christian
church endorsed a “just wage” doctrine that supported class structure. Japanese employer
 place heavy emphasis on experience in their internal pay structures. Global competition and
an aging workforce has made age-based pay an expensive affair

5. Organization strategy: The belief is that pay structures that are not aligned with
organisation strategy may become obstacles to the organisation’s success. Aligned structures
today may become an obstacle tomorrow. So compensation structure must be aligned with
strategies, yet adaptable.

6. Organization Human Capital: The education, experience, knowledge, abilities and skills
required to perform the work influences on internal structures. The greater the value of skills
& experience more will pay and command.

7. Organisation work design: Technology used in producing goods and services influences
the organizational design, the work to be performed, and the skills/knowledge required to
perform the work. Technology difference contributes to the different structures observed.
Recently work design has changed a lot; many people who work in organizations are not
employees of these organisations. Temporary and outsourced work force is seen more and
more. Another major work design change is delayering, entire levels of work have
disappeared for example HP. Cuts unnecessary, non-contributing work. Adds work to other
jobs, enlarges them, changes the job’s value and structure

8. Overall HR policies: Organization’s other HR policies also influence internal pay

structures, many organisations tie money to promotions to induce employee to apply for
higher-level positions. Frequent promotions offer a sense of feeling of career progresses to
employee.

9. Internal labor markets: Combining External and organization Factors: Internal

labor markets combine both external and organization factors. It determines rules
and procedures that
i. Define pay for different jobs within a single organization
ii. Allocate employees among those different jobs

They are aligned; yet adaptable pay structures may be required. Individuals recruited
initially at entry-level jobs and later promoted or transferred to other jobs inside the
organization. External factors influence on pay for entry jobs, where difference for non-entry
jobs tends to reflect internal factors.
Exhibit 5: Illustration of an internal labor market

10. Employee acceptance: Employees judges the fairness of the salary by comparing with
others salary, Sources of fairness includes procedural justice (process by which a decision is
reached: the right to an attorney, the right to an impartial judge, and the right to receive a
copy of arresting officer’s statement) and distributive justice (fairness of the decision:
guilty). At the same acceptability to employees involved is very essential.
Research suggested that pay procedures are more likely to Perceived fair when they are.
i. Consistently applied to all employees
ii. Employee participated in the process
iii. Appeal procedures are included.
iv. Data accurately used.
In certain cases, pay is so low that no amount of participation could overcome their
dissatisfaction.
11. Pay structures change: Pay structure change in response to external factors such as skill
shortages, overtime this distorted (misleading) pay became accepted as equitable and
customary and efforts to changes them are resisted. The new norms form around the new
structure. This ‘Change-and-congeal” process does not yet support the constant changes
occurring in today’s economy.
STRATEGIC CHOICES IN DESIGNING INTERNAL STRUCTURES
Aligned pay structures support the way the work gets done, fit the organization’s business
strategy, and are fair to employee. Greater internal alignment –fit-is more likely to lead to
success. Misaligned structures become obstacles. Fitting or tailoring the pay structure to
be internally aligned involves two strategic choices
a. How tailored to organization design and work flow to make the structure
b. How to distribute pay throughout the levels in the structure.
Tailored versus loosely coupled
i. Tailored: Here jobs are well designed with detailed steps or tasks and
there exists very small pay differentials among jobs. For Example, 1:
McDonald’s or Wall-Mart (low-cost, customer-focused strategy)
ii. Loosely coupled pay structure involves flexibility and requires constant
innovation. For example, 3M’s business strategy (product innovation and
short product-design-to-market cycle times).
Egalitarian versus hierarchical
c. Egalitarian (democratic or equality) structures send the message that all
employees are valued equally fewer levels and smaller differentials
between adjacent levels and between highest- and lowest-paid workers.
On the other hand, ‘Averagism’ brings to light that equal treatment can
mean more knowledgeable employees feel underpaid.
d. Hierarchical structures send the message that the organization values the
differences in work content, individual skills, and contributions to the
organization and this multiple levels include detailed descriptions of work
done at each level.

WHICH INTERNAL STRUCTURE FITS BEST?

There is no hard and fast rule that which structure fits best, but the guidance from the evidence
can confirm the fit.
EQUITY THEORY:
They will also feel their internal pay structures are fair even when they are relatively low in
internal structure. Fairness, research suggests that employees judge fairness by multiple
comparisons.
i. Comparing to jobs similar to their own
ii. Comparing their job to others at the same employer
iii. Comparing their jobs’ pay against external pay levels.
Results from these comparisons depend in part on the accuracy of employee knowledge of other
employee’s jobs, internal structures and external pay levels.

Social comparisons
SELF OTHER(S)
Outcomes/inputs : outcomes/inputs
Outcomes = pay, recognition, use abilities
Inputs = education, performance, effort

TOURNAMENT THEORY: MOTIVATION AND PERFORMANCE: Economists have

focused more directly on the motivational effects of structures as opposed to people’s
perceptions of structures. This theory can be better explained as where all players will play better
in the first tournament, where the prize differentials are larger. Further Greater difference
between an employee’s salary and the boss’s, harder he/she will work, this difference decides the
effort. Several studies have suggested that “winner-takes-all” this supports that performance
improves with larger differentials at the top levels of the structure.

INSTITUTIONAL MODEL: COPY OTHERS: Sometimes internal pay structures are adopted
because they have been called as a “best practices”. Organizations simply copy others.
Benchmarking behavior include the rush to outsource jobs, to emphasize teams, to deemphasize
individual contributions, and to shift to a competency-based pay system, often with little regard
to whether any of these practices fit the organization or its employees and add value.

This model postulates that very few firms are “first movers”; they copy innovative practices after
innovators have learned how to make the practices work. And the copiers are little concern for
the alignment and even less innovative pay practices.

The above exhibit summarizes the effects attributed to internally aligned structures. Impact of
internal structures depends on context in which they operate.
 More hierarchical structures are related to greater performance when the work flow
depends on individual contributors.
 High performers quit less under more hierarchical systems when:
o Pay is based on performance rather than seniority
o When people have knowledge of the structure
 More egalitarian structures are related to greater performance when close collaboration
and sharing of knowledge are required. The competition fostered “winner-take-all”
doesn’t work when team based performance is asked for.
 Impact of any internal structure on organization performance is affected by other
dimensions of the pay model
– Pay levels (competitiveness)
– Employee performance (contributions)
– Employee knowledge of the pay structure (management)
CONSEQUENCES OF STRUCTURES: Why compensation analyst has to worry about
internal alignment? Why not simply pay employees what job deserves? Why not company pay as
per market pay or what competitors are paying to determine internal wage differentials? Or why
not let a government agency decide?

Importance of internal alignment

 Efficiency: Research shows that an aligned structure can lead to better organization
performance. The size of the differentials between the entry level in the structure and
the highest level in the organization encourages employees remain in the
organization. Internal pay structures imply future returns.

 Fairness: Deviation from acceptable wage structure results in turnover, grievance

and reduced motivation. On group argues that If fair (sizable) differentials among
jobs are not paid, individuals may harbor ill will toward the employer, resist change,
change employment if possible, become depressed and lack “ that zest and
enthusiasm that makes high efficiency and satisfaction at work”

 Compliance: Internal pay structures must comply with the regulation of the
countries in which the organization operates. While the research on internal
alignment is very information, there is still a lot we do not know. This is about
number of levels, size of the differentials, criteria for employees to advance in pay
structure? All these questions have been answered in module.

Aligning the pay structure to fit the organization’s conditions is likely to lead
competitive advantage for the company